Motley Fool: See stock-market drops as buying opportunity

Sunday

Sep 10, 2017 at 5:00 AM

Q: How freaked out should I be when the market crashes, say, 274 points, as it did recently? — C.D., Santa Rosa, California

A: Don't freak out. Stocks and the overall market move up and down every day that the market is open, with some of those moves being sizable. It's smart to think in percentages instead of points, though — a concept that the financial media doesn't seem to grasp. On Aug. 17, for example, the Dow Jones industrial average dropped a seemingly massive 274 points — the second-largest one-day decline in 2017. The Dow began that day at 22,025, though, and ended not that far away, at 21,751. Those 274 points represented a decline of only 1.24 percent.

There have been — and will be — many moves of much more than 1.24 percent in the market. In 1987, for example, the Dow plunged 157 points, but at the time, that represented a fall of 8 percent. A 2008 drop of 778 points was a 7 percent decline. Meanwhile, a seemingly small shrinkage of 38 points in 1929 was a 13 percent drop, followed the next day by a 12 percent fall.

Despite its volatility, the stock market's long-term trend has always been up. Only keep money you won't need for five (or even 10) years in stocks — and when the market plunges, grab your shopping cart.

Fool's School: Betting against stocks

The way to make money in stocks is to buy low and sell high, right? Well, yes, but many investors don't realize that you also can make money in stocks by reversing that: buying high and then selling low. It's called "shorting."

Here's how it works: Imagine GroverCleveland.com (ticker: GROVY) has gone public. While others may be excited about the company, you have little faith in it and expect the stock to sink. You go to your brokerage and put in an order to short GROVY. The brokerage will "borrow" shares from a GROVY shareholder's account and sell them for you. Later, if the share price does drop, you'll "cover" your short, which involves buying shares on the market (at a lower price) to replace the ones you borrowed. If you shorted GROVY at $90 and covered when it fell to $70, you made $20 per share (less commissions). This process might seem crazy, but it's legal and commonly done.

You can make money with shorting in any kind of market. If the market plunges, your shorts probably will fall, boosting your portfolio's performance. Even in a strong market, poorly performing companies will often fall in value, rewarding those who bet against them.

There's a big downside to shorting, though. If the stock price rises and then you sell, you'll lose money. It gets worse: With shorted stocks, you can gain only up to 100 percent because a stock price can't fall lower than zero. But if your shorted stock keeps rising, your downside is theoretically unlimited. Because you can actually lose more than the money you invested, you need to keep a close eye on your shorts.

Shorting stocks also involves working against the overall long-term upward trend of the market. Companies you're sure are overvalued can remain overvalued or keep rising. And if you short a company, you'll have its management working against you to make the company succeed.

Shorting can be effective, but it's only for seasoned investors. Many experienced investors do very well without it.

Foolish Trivia: Name that company

I trace my roots to 1847, when one of my co-founders, an immigrant, invented America's first candy machine — a lozenge cutter — followed by a sugar pulverizer. I churn out more than 600 million of my lozenge-like flagship product annually. It has been so popular that it's been part of supplies on Arctic expeditions going back to 1913 and was given to U.S. troops in World War II. I'm based in Revere, Massachusetts, and my offerings today include Squirrel Nut Zippers, Mighty Malts, Canada Mints, Mary Janes, Sweethearts, Candy Buttons, Clark Bars, Slap Stix and Sky Bars. Who am I?

Last week's trivia answer

I'm the product of a 2010 merger of two companies, both of which trace their roots to the early 1900s, when one was making pretzels and the other selling peanuts. I introduced peanut-butter sandwich crackers in 1913. Today, I'm a snack giant, with brands such as Kettle Brand, KETTLE Chips and Cape Cod. My market value recently topped $3.5 billion, and I employ more than 6,500. Who am I? (Answer: Snyder's-Lance)